Patenting Tax Ideas

Executive Summary

TSPs
have been issued in many areas, and many applications
are currently pending.

Such
patents thwart Congressional intent and undermine the
integrity of, and the public’s confidence in, the tax
system.

The
AICPA will continue to work with the IRS, USPTO,
Treasury and Congress to handle—and hopefully
resolve—this emerging issue.

One of the greatest
challenges tax practitioners face in providing quality tax
services to clients is to keep abreast of the
ever-changing complexity of the tax law. Added to this
challenge is the burden of determining whether the chosen
advice is another party’s exclusive property. While this
may seem absurd, in the real world of tax consulting, tax
advisers must now contend with certain practitioners and
companies seeking patents to protect their exclusive right
to use various tax planning ideas and techniques they
claim to have developed.

Tax practitioners may be
surprised to find that tax strategies they have used
routinely in practice are now patented and unavailable for
use without the patent holder’s permission. The trend of
patenting tax strategies is on the rise. This article
explores tax-strategy patenting. It provides an overview
of the issue and discusses the AICPA’s concerns and
activities to keep its members informed, as well as its
attempts to seek a legislative remedy that will stem the
tide of these types of patents.

Background

The Patent Act of
19521 provided that patents may be granted for
innovations that are useful, novel and nonobvious. Under
35 USC Section 271, a patent gives its holder the
exclusive right to make, use and sell the patented idea.
The consequences of infringing a patent can be
substantial. The remedies for patent infringement under 35
USC Sections 283 and 284 include injunctive relief and
money damages equal to lost profits or a reasonable
royalty. Money damages can be tripled in cases of willful
infringement, as authorized under 35 USC Section 284;
under 35 USC Section 285, attorneys’ fees can be awarded
to the prevailing party in exceptional cases. Issued
patents are presumed valid; under 35 USC Section 282, an
accuser must overcome this presumption with clear and
convincing evidence to invalidate a patent. Even if an
accused is not found liable, defending a lawsuit can be
costly.2

In 1998, the Federal Circuit, in
State Street Bank & Trust,3 held
that business methods are patentable. Since this decision,
patents for business methods have flourished. In some
cases, these patents involve processes that would seem to
be neither novel nor nonobvious (i.e., other reasonably
intelligent people would come to the same or a similar
conclusion when confronted with the same or similar
issue).

Recently, the Supreme Court held4
that the long-standing test used by the lower courts
to determine whether an idea was nonobvious was not being
applied correctly (and, in fact, was being applied too
strictly). The opinion stated that for an idea to be
nonobvious, it must be (1) one that would not have
occurred to persons of ordinary skill and intelligence in
the field of endeavor involved; or (2) previously
available knowledge that would have caused a person of
ordinary intelligence to affirmatively believe that the
idea would not work. Since this decision was just handed
down, it remains to be seen what effect it will have on
the proliferation of patents for business methods in the
future.

The patenting of business methods has
recently crept into the practice of tax planning. At press
time, 60 tax-strategy patents (TSPs) have been granted; 86
are pending.5 There may be additional TSPs;
about 10% are generally unpublished, because applicants
can elect not to publish a patent if no protection is
being sought in a foreign jurisdiction.6 Also,
it can take up to 18 months for a patent application to be
published and listed on the USPTO website. As discussed
below, many of these patents deal with planning techniques
routinely used by tax practitioners in delivering tax
services to clients.

Reasons for
Concern

SOGRAT patent: The primary catalyst for
the concern of the AICPA and other tax practitioners was a
2006 infringement suit over the “SOGRAT patent.” Awarded by
the USPTO on May 20, 2003, to Robert C. Slane of Wealth
Transfer Group LLC, the SOGRAT patent describes an estate
planning technique that uses grantor retained annuity trusts
(GRATs) to transfer nonqualified stock options (NQSOs) to
younger generations, with few or no gift tax
consequences.7

GRATs are permitted under Sec.
2702 and the regulations there under. Many estate planners
are familiar with, and routinely use, GRATs to shift a
variety of different types of assets to younger
generations. Thus, it came as quite a surprise to many
estate planners when an article touting the estate tax
benefits of placing NQSOs into a GRAT noted that the
technique had been patented by one of that article’s
authors.8 This surprise grew into concern when
the patent holder instituted the above-mentioned patent
infringement suit against a taxpayer who implemented the
technique without its permission.

Warning letters: As previously stated,
money damages can be tripled in cases of willful
infringement (which requires knowledge of the patent).
Some patent holders have resorted to mail campaigns and/or
press releases touting their patents and warning other tax
practitioners that they may be infringing on said patents.
For example, one patent infringement warning letter
addressed a method for financing future needs of an
individual or future intentions on the death of such
person, and a method for investing long-term assets of
tax-exempt charities. The letter noted that the allowed
claims in the patent involve investments used for
charitable remainder trusts, pooled-income funds,
charitable gift annuities, charitable lead trusts and
permanent endowment funds.9

Part of this
patent resembles the facts and results of Letter Ruling
900904710 and TAM 9825001.11 In
those rulings, the IRS permitted a net-income charitable
remainder unitrust to invest in a tax-deferred annuity
contract for the purposes of controlling the timing and
amount of income distributions and to otherwise provide a
guaranteed death benefit payable to the charitable
remainder interest holder. The patent purports to achieve
a similar result through the use of tax-deferred
arrangements.

The patent holder also sent a press
release to the Planned Giving Design Center (PGDC), a
professional organization that provides advice on
charitable planning and taxation. An article12
written by the PGDC’s editor noted that the letter ruling
and TAM are well known to members of the insurance
community in particular, “which have since facilitated
thousands of annuity invested charitable remainder trusts
since 1990.” The article further noted that these rulings
are also well known to the IRS, which issued them and
subsequently discussed such arrangements in its 1999
Continuing Professional Education text. The IRS also added
these rulings to its annual “no-ruling” list as it studied
whether they conveyed an inappropriate tax benefit to
taxpayers. The article noted that all of these events
occurred well in advance of the date the holder applied
for his patent (2004).

In light of that patent, the
AICPA and American Bar Association (ABA) asked the USPTO
whether IRS rulings were considered “prior art” (and,
thus, not novel) if they were not listed in the “Other
References” section of a patent application. The patent
application did not contain a reference to either ruling.
The USPTO replied that, although it had not required such
information in the past, it would start requesting it for
financial-type patents under its Rule 105 (which is used
to ask applicants for more information).

Deferred compensation: A patent on
hedging liabilities associated with a
deferred-compensation plan was granted and assigned to
Goldman Sachs & Company.16 The patent
purports to provide a mechanism to hedge the compensation
expense liabilities of an employer providing deferred
compensation to one or more employees.

IRAs: A patent has been granted to
evaluate the financial consequences of converting a
traditional IRA to a Roth IRA.17 It describes a
computer-implemented process for computing the tax
consequences of converting to a Roth IRA and various
options for funding the taxes, such as term insurance to
fund the Federal tax liability of early withdrawal for
premature death, calculating the entire rollover amount
and financing the tax and insurance premium.

FSAs: A patent has been granted on
flexible spending accounts (FSAs).18 The patent
sets forth a method to calculate costs using a “health
cost calculator” and “flexible spending account
calculator.”

FOLIOfn: The trend to patent tax
ideas is only in its infancy; however, several individuals
and companies already have applied for multiple patents.
For example, FOLIOfn, Inc., a brokerage and investment
solutions company, holds three TSPs. It has developed
methods for tracking and organizing investments and has
patented mechanisms and processes that allow users to view
and manipulate potential tax consequences of investment
decisions. Several of FOLIOfn’s other business-method
patents are in practice via large licensing agreements.
The company is similarly looking for licensing
opportunities for its three TSPs but has not yet secured
any deals.19

As far as the AICPA is
aware, only one of its members (a sole practitioner) has
applied for a TSP. The AICPA Tax Division staff discussed
the issue with that member. The AICPA has confirmed that,
currently, none of the “Big Four” accounting firms holds
TSPs.

AICPA Issues

In a Feb. 28, 2007,
letter20 to Congress, the AICPA outlined its
concerns and position on patenting tax strategies. Its
position is that TSPs:

Limit
taxpayers’ ability to use fully tax law interpretations
intended by Congress;

May cause some
taxpayers to pay more tax than Congress intended or more
than others similarly situated;

Complicate
the provision of tax advice by professionals;

Hinder compliance by taxpayers;

Mislead taxpayers into believing that a patented
strategy is valid under the tax law; and

Preclude tax professionals from challenging the
validity of a patented strategy.

The
AICPA is concerned about patents for methods that
taxpayers use in arranging their affairs to minimize tax
obligations. TSPs may limit taxpayers’ ability to use
fully interpretations of law intended by Congress. As a
result, they thwart Congressional intent and, thus,
undermine the integrity of, and the public’s confidence
in, the tax system. TSPs also unfairly cause some
taxpayers to pay more tax than (1) intended by Congress or
(2) others similarly situated. The AICPA believes that the
conflict with Congressional intent highlights a serious
policy reason against allowing patent protection. Allowing
a patent on a strategy for complying with a law or
regulation is not sound public policy because it creates
exclusivity in interpreting the law.

The AICPA is
also concerned with tax law simplicity and administration.
TSPs greatly complicate tax advice and compliance. Tax law
is already quite complex. The AICPA believes that the
addition of rapidly proliferating patents on tax-planning
techniques and concepts will render tax compliance much
more difficult.

Because TSPs are granted by the
Federal government, the AICPA is concerned that they pose
a significant risk to taxpayers. Taxpayers may be misled
into believing that a patented tax strategy bears the
approval of other government agencies (e.g., the IRS) and,
thus, is a valid and viable technique under the tax law.
However, this is not the case; the USPTO does not consider
the viability of a strategy under the tax law. The USPTO
is authorized only to apply the criteria for patent
approval as enacted by Congress and as interpreted by the
courts. The IRS is not involved in the USPTO’s
consideration of a TSP application.

The AICPA is
concerned that tax professionals also may be unable, as a
practical matter, to challenge the validity of TSPs as
being obvious or lacking novelty, due to their
professional obligations of client confidentiality. Tax
advisers may also find it difficult to defend
patent-infringement lawsuits due to client
confidentiality. The USPTO will also find it difficult, if
not impossible, to determine whether proposed tax
strategies meet the statutory requirements for
patentability because tax advice is generally provided on
a confidential basis.

The usefulness of TSPs is
also questionable. The AICPA believes that some of these
patents may be sought to prevent tax advisers and
taxpayers from using otherwise legally permissible
tax-planning techniques, unless they pay a royalty.

The AICPA is concerned that both tax practitioners and
taxpayers may be sued for patent infringement, whether or
not the infringer knew about the patent. A taxpayer can
infringe a patent without intent or knowledge of it;
ignorance of an applicable patent is not a
defense.21 Practitioners must be aware that
once they know that a particular tax strategy is patented,
using that strategy without the patent holder’s permission
may expose them to claims of willful infringement and
triple damages. Unfortunately, the current environment may
leave some practitioners with no recourse, other than
engaging patent counsel to review and monitor techniques
they routinely use.

Advocacy Efforts
and Communications

Background: In November 2005 and
February 2006, the AICPA Trust, Estate & Gift Tax TRP
discussed this emerging issue with IRS representatives. In
addition, AICPA President Barry Melancon discussed this
issue with then-IRS Commissioner Mark Everson on Oct. 17,
2006, advising him of the AICPA’s concern and desire to take
legislative action.

In January 2006, the AICPA Tax
Division’s Tax Executive Committee (TEC) decided to form
the PTF. This article’s authors chair and staff that task
force, respectively. The PTF was formed with both large-
and small-firm members, from various technical areas of
the AICPA Tax Division, including individual,
international, partnership, S corporation, tax policy and
legislation, and trust, estate and gift taxes. The task
force held several conference calls and meetings,
including one call with a patent expert who explained the
basis for patents and the application process.

In
June 2006, the TEC authorized some PTF members to
participate in a joint multi-professional organization
task force (including the AICPA, the ABA’s Real Property,
Probate and Trust Law Section and Tax Section, the
American College of Trust and Estate Counsel and the
American Bankers Association) on the issue. The joint task
force had several conference calls; its chair attended a
PTF meeting in November 2006.

In July 2006, prior
to the Congressional hearings on the issue, the PTF
discussed its concerns with Capitol Hill staff. This
article’s authors attended the hearing, then updated AICPA
Tax Division members about the issue and hearing via an
electronic alert (e-alert) in August 2006.

In
October 2006, the AICPA up-dated members via an update to
state CPA societies. In February 2007, the AICPA sent to
the leadership of the House and Senate tax-writing and
judiciary committees its position on tax-strategy
patenting, including legislative proposals. E-alerts went
out to the AICPA membership and were included in the April
2007 issue of the AICPA’s The CPA Letter.22 In
addition, PTF members authored Journal of Accountancy
articles on the subject.23

In March
2007, the PTF drafted and submitted comments24
to Treasury on the regulations for “reportable
transactions.” These comments recommended that Treasury
not require taxpayers to report patented transactions as
reportable transactions, but require the patent holder or
USPTO to disclose when the patent is issued.

The
AICPA Congressional and Political Affairs group has made
TSPs a top priority and is in discussions with Congress
and its staffs, as well as the USPTO’s General Counsel and
Director of Business Method Patents, to develop and enact
legislation designed to bar grants of, or provide immunity
for taxpayers and practitioners from liability related to,
such patents. Currently, the AICPA’s legislative efforts
are focused on the judiciary committees, which consider
and vote on any patent legislation.

Action: The AICPA has taken a
pro-active role against the patenting of tax ideas. Most
of its efforts are reflected in a website it has created
on the subject,25 which contains:

AICPA comments to Congress, Treasury and the IRS,
updates to members, and its PTF roster;

Comments of other groups and the Joint Committee on
Taxation;

USPTO links;

Information on specific TSPs;

Related
articles and other information; and

Links
to additional resources.

Recommended
Steps

To minimize
potential liability until a legislative solution is
enacted, tax practitioners should take the following
steps, as appropriate, in response to TSPs:

Stay current on
matters regarding TSPs by continually visiting the
AICPA website on the subject.

Read articles and
attend conferences about TSPs.

Continually visit the
USPTO website to determine if a tax idea, technique or
strategy that a tax practitioner intends to recommend
to a client has been issued a patent or if one is
pending.26

If a strategy is either
already patented or is similar to a patented
strategy:

Advise the client
about the patent’s existence, the options available
and the associated risks;

Determine whether
patent counsel is needed to further investigate the
patent; and

If there is a relevant
patent, determine whether to negotiate with the
patent holder to be able to use the strategy.

Proposed Legislative
Solution

The AICPA has
considered various administrative solutions to this issue
and concluded that they are insufficient. In its Feb. 28,
2007, letter, it encouraged Congress to develop
legislation to eliminate the harmful consequences of TSPs
by either (1) restricting the issuance of such
patents27 or (2) providing immunity from patent
infringement liability for taxpayers and tax
practitioners.

HR 2365,
legislation sought by the AICPA to limit damages and other
remedies with respect to patents for tax-planning methods,
was introduced by Rep. Rick Boucher (D-VA) on May
17, 2007, with initial co-sponsors Reps. Bob Goodlatte
(R-VA) and Steve Chabot (R-OH). Reps. Boucher, Goodlatte
and Chabot are senior members of the House Judiciary
Committee, which has jurisdiction over patent legislation.
The bill was referred to that committee. As of May 30,
2007, 14 cosponsors had signed onto the bill. AICPA
efforts and discussions continue with other members of
Congress, including members of the Senate Judiciary
Committee. On May 16, 2007, Reps. Lamar Smith (R-TX),
Boucher and Goodlatte sent a letter requesting a hearing
on the issue to Howard Berman (D-CA), chairman of the
House Judiciary Committee Subcommittee on Courts, the
Internet, and Intellectual Property.

The Future

The AICPA continues to work
with Congress to make legislative changes regarding the
patenting of tax strategies. It is also currently working
with the USPTO to determine how both organizations might
work together to better scrutinize such patent applications.
The AICPA will continue to focus its legislative efforts on
the judiciary committees and to work with the USPTO, IRS and
Treasury, as well as other professional groups, to educate
tax advisers on TSPs and to enhance the flow of information
among the groups. The PTF and the AICPA will continue to
update its website with additional resources for members,
develop other educational and practice-oriented tools and
study and address related professional ethical issues.

Conclusion

Practitioners and taxpayers need
to (1) be aware that TSPs are being granted and (2) review
planning approaches and consider consulting with patent
counsel, if appropriate. Tax advisers should ask clients
about their use of tax strategies, as they may be
unknowingly using patented ones. The AICPA will continue
to work with the IRS, USPTO, Treasury and Congress to
handle—and hopefully resolve—this emerging issue.

2 In 2005, it was reported that
the average patent infringement case typically costs
$650,000 per party when the amount at risk is under $1
million, and $2 million per party when the amount at risk
is $1 million to $25 million; see American Intellectual
Property Law Association, “Report of the Economic Survey
2005,” p. 22, available at www.aipla.org/Content/NavigationMenu/Professional_Development/Law_Practice_Management/Law_Practice_Management.htm.
See also Statement of Ellen Aprill, Testimony Before
the Subcommittee on Select Revenue Measures of the House Committee on Ways and
Means (7/13/06), at fn. 4.

7 On Jan. 6, 2006, Wealth Transfer
Group LLC filed a complaint in a Connecticut Federal
district court against John W. Rowe, alleging that he
infringed its SOGRAT patent; see Wealth Transfer Group
LLC v. John W. Rowe, Dkt. No. 3:06-cv-00024-AWT.
Wealth Transfer Group LLC sought an injunction and damages
against Rowe after discovering (through Securities and
Exchange Commission filings) that he funded a GRAT with
NQSOs. On Feb. 6, 2007, the parties filed a joint motion
to stay the case, stating that they have agreed in
principle to resolve the matter. On March 9, 2007, the
court approved a confidential settlement to end the
litigation, without Rowe admitting liability. The SOGRAT
patent is at http://patft.uspto.gov/netacgi/nph-Parser?Sect1=PTO2&Sect2=HITOFF&p=1&u=/netahtml/PTO/search-bool.html&r=1&f=G&l=50&co1=AND&d=PTXT&s1=SOGRAT&OS=SOGRAT&RS=SOGRAT.

15 See Lederman, “Tax-Related
Patents: A Novel Incentive or an Obvious Mistake?” 105
J Tax’n 325 (December 2006), at p. 327; see
also “CB Richard Ellis Investors Patents $73 Million
Tenancy-in-Common Structure” (9/25/03), available athttp://netleasenews.blogspot.com/2003_09_01_archive.html,
a press release on the announcement of CB Richard Ellis
Investors’ tenancy-in-common (TIC) offering (known as the
1031FORT). Valued at $73.5 million and primarily targeting
Sec. 1031 exchangers, it is one of the largest offerings
of TIC real estate interests.

The winner of The Tax Adviser’s 2014 Best Article Award is James M. Greenwell, CPA, MST, a senior tax specialist–partnerships with Phillips 66 in Bartlesville, Okla., for his article, “Partnership Capital Account Revaluations: An In-Depth Look at Sec. 704(c) Allocations.”

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